1 THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES THE INSTITUTE OF CHARTERED SECRETARIES AND ADMINISTRATORS International Qualifying Scheme Examination HONG KONG TAXATION DECEMBER 2012 Suggested Answer The suggested answers are published for the purpose of assisting students in their understanding of the possible principles, analysis or arguments that may be identified in each question
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THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES
THE INSTITUTE OF CHARTERED SECRETARIES AND
ADMINISTRATORS
International Qualifying Scheme Examination
HONG KONG TAXATION
DECEMBER 2012
Suggested Answer
The suggested answers are published for the purpose of assisting students in their
understanding of the possible principles, analysis or arguments that may be identified in
each question
2
SECTION A
1.
Lifestyle Limited carries on a manufacturing and trading business in Hong Kong. The
company’s income statement for the year ended 31 March 2012 showed net income of
$7,200,000 which is after taking into account the following items:
Income: Note $
Dividend from a Hong Kong listed company 16,000
Interest income 1 85,000
Proceeds from assignment of rental income 2 900,000
Profit on disposal of patent 3 140,000
Expenses:
Bad debts 4 208,000
Contribution to retirement scheme 5 1,543,000
Depreciation 473,000
Donation 6 50,000
Exchange differences 7 41,000
Interest expenses 8 142,000
Legal and professional fees 9 100,000
Profits tax 785,000
Notes to the accounts:
1. Interest income: $
Interest on deposits placed with Hang Seng Bank in Hong Kong 32,000
Interest on deposits placed with HSBC in Singapore 48,000
Interest on tax reserve certificate 5,000
85,000
2. The company let a commercial unit in Kwun Tong to a tenant at $30,000 per month from April 2011 onwards for a fixed term of three years, and assigned the right to receive rental income under the lease to a finance company for $900,000. This amount was immediately recognised in the income statement.
3. The company acquired a patent 10 years ago for use in the production process at a cost of $300,000. The patent was disposed during the year for $440,000 and a gain of $140,000 was recognised in the accounts.
4. Bad debts expenses: Increase in allowance for doubtful trade accounts for which recovery action has been taken in vain
70,000 Increase in allowance for doubtful accounts based on 2% of the trade debts outstanding
26,000
Trade debts written off 112,000
208,000
3
5. Contribution to recognised retirement scheme:
Contribution for employees (at 10% of salaries) 1,260,000
Contribution for directors (at 20% of directors’ fees) 300,000
Refund from the scheme for employees who have left the
company
(17,000)
1,543,000
6. The company has donated products with book value of $50,000 to an elderly care
home which is an approved charity in Hong Kong.
7. Exchange differences:
Exchange loss on conversion of foreign currency time deposits 22,000
Exchange loss on collecting trade debts 19,000
41,000
8. Interest expenses:
Bank interest paid to HSBC in Hong Kong* 97,000
Loan interest paid to a shareholder (unsecured) 45,000
142,000
* The borrowing was secured by the deposits placed with the same bank in Singapore
(see note 1 above) and personal guarantees given by the shareholders. At all material
times, the borrowing was greater than the amount of deposits.
9. Legal and professional fees:
Fees for annual audit and tax filing 60,000
Legal fees for new lease (see note 2 above) 3,000
Other (allowable) 37,000
100,000
Additional note:
Total depreciation allowances agreed with the Assessor for the year are $330,000.
Additional information:
The company plans to set up a branch in Mainland China to sell its products in the
Mainland. While the solicitation and negotiation of contracts will be conducted in the
Mainland, the production will continue be carried out in Hong Kong. The board of directors
would like to know if the profits from such sales could be claimed as offshore income. The
board understands that setting up a branch in the Mainland will create tax exposure under
the Corporate Income Tax Law in the Mainland. However, protection or relief is available
to a Hong Kong company under The Arrangement between the Mainland of China and the
Hong Kong SAR for the Avoidance of Double Taxation and the Prevention of Fiscal
Evasion with respect to Taxes on Income (Mainland/HK CDTA).
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REQUIRED:
1. (a) Prepare the Hong Kong profits tax computation for Lifestyle Limited for the
year of assessment 2011/12. Ignore provisional tax.
Ans (a) Lifestyle Limited
Profits tax computation
Year of assessment 2011/12
Basis period: Year ended 31 March 2012 (Section 18B(1))
$ $
Profit per accounts 7,200,000
Add: Depreciation 473,000
Donation in kind 50,000
Profits tax 785,000
Sales proceeds of patent 300,000
Increase in general allowance for doubtful
debts
26,000
Excess contribution for directors ($300,000 x
5%/20%)
75,000
Exchange loss on converting time deposits 22,000
Bank interest to HSBC 48,000
Loan interest to a shareholder 45,000
Legal fee for new lease 3,000 1,827,000
9,027,000
Less: Dividends (16,000)
Interest on deposits - Hang Seng Bank (32,000)
Interest on deposits - HSBC (48,000)
Interest on tax reserve certificate (5,000)
Profits on sale of patent (140,000) (241,000)
8,786,000
Less: Depreciation allowances (330,000)
Assessable profit 8,456,000
Profits tax payable at 16.5% 1,395,240
Less: Tax reduction (75%, max $12,000) (12,000)
Final profits tax payable 1,383,240
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1. (b) Analyse the proper tax treatments for all items given in notes 1 to 9 above.
Ans (b) Interest income
Interest income received or accrued to a corporation is taxable under section
15(1)(f) if the person carries on a business in Hong Kong and the interest
income is arising from Hong Kong
Lifestyle Limited carries on business in Hong Kong
Interest on deposit placed with Hang Seng Bank is sourced in Hong Kong
and chargeable to profits tax
However, interest can be exempt because the deposits were placed with a
financial institution in Hong Kong and they were not used to secure any bank
borrowing
Interest on deposits placed with HSBC in Singapore was sourced outside
Hong Kong and is not taxable
Interest on tax reserve certificates is exempt under section 26A(a)
Assignment of rental income
Sum received by a person as consideration in respect of the transfer of a
right to receive taxable rental income is deemed to be a taxable trading
receipt under sections 15(1)(m) and 15A unless the ownership of the
property is also transferred
$900,000 received by Lifestyle Limited is taxable
Disposal of patent
The cost of purchasing the patent should have been deducted under section
16E(1) when it was acquired 10 years ago
The sale proceeds are deemed to be a taxable receipt under section 16E(3)
Effective 2011/12, the taxable receipt is restricted to the deduction previously
claimed, i.e. $300,000 only
Bad debts expenses
Trade debts written off are deductible under section 16(1)(d) if they are
proved to have become bad and were included as taxable trading receipts
Allowance based on 2% of trade debts outstanding is not regarded as
“incurred” and cannot be deducted
Where recovery action has been taken on trade debts in vain, it can be
estimated to the satisfaction of the assessor that they have become bad and
are deductible
Contribution to retirement scheme
Annual contribution to recognised retirement scheme can be deducted up to
15% of the total emolument of the employee by virtue of section 17(1)(h)
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Contribution for the employees is not excessive and can be deducted in full
Contribution for the directors has to be reduced to the 15% limit
Refund from recognised retirement scheme is deemed to be taxable receipts
under section 15(1)(h) to the extent that the relevant contribution has been
allowed as a deduction
Donation
Donation to approved institution must be in money, not in kind
Donation of products is not “money” and cannot be deducted under section
16D
Exchange differences
Time deposits are capital investment of a company (CIR v Li & Fung);
exchange loss on conversion of foreign currency deposits is capital in nature
and not deductible
Exchange loss on collecting trade debts is revenue loss and deductible
Interest expenses
To be deductible, interest expenses must be incurred in the production of
chargeable profits under section 16(1)(a)
Bank interest paid to HSBC is interest on money borrowed from a financial
institution and satisfies the condition under section 16(2)(d)
Under the secured loan test, the borrowing was secured by deposits placed
in Singapore generating non-taxable interest income
Deduction has to be reduced by the amount of tax-free interest income by
virtue of section 16(2A); only $49,000 ($97,000 - $48,000) can be deducted
The shareholder loan was borrowed from a person other than a financial
institution and section 16(2)(c) has to be considered
Since the shareholder is likely not to be liable to profits tax for the interest
income received, the condition under section 16(2)(c) cannot be fulfilled and
no deduction is allowed
Legal and professional fees
Fees for annual audit and submission of tax return were incurred in the
normal course of business to discharge normal legal obligations of a taxpayer
and with a view to earn profit; they are deductible expenses
Fee for preparing new tenancy agreement is of a capital nature and
non-deductible
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1. (c) Advise the board on the Hong Kong issues relating to the plan of setting up
a branch in the Mainland and the protection or relief available under the
Mainland/HK CDTA .
Ans (c) Under section 14(1), a person is chargeable to profits tax if he carries on a
business in Hong Kong and the profits arise in or are derived from Hong
Kong
Only operations which directly produce the profits are relevant; one should
focus on the effective causes for earning the profits, activities that are
antecedent or incidental can be ignored
Although the sales contracts are effected outside Hong Kong, it is likely that
the IRD would regard the production process in Hong Kong to be the
profit-making activities
All the profits from selling the goods to customers in the Mainland would likely
be chargeable to Hong Kong profits tax
Under Article 7 of the Arrangement between the Mainland of China and the
Hong Kong SAR for the Avoidance of Double Taxation and the Prevention of
Fiscal Evasion with respect to Taxes on Income, the profits of a Hong Kong
enterprise shall be taxable only in Hong Kong unless the enterprise carries
on business in the Mainland through a permanent establishment situated
therein
However, in such a case only the profits attributable to that permanent
establishment may also be taxed in the Mainland
The term “permanent establishment” is provided in Article 5 to mean a fixed
place of business through which the business of an enterprise is wholly or
partly carried on
It also includes especially a place of management; a branch; an office; a
factory; a workshop; a mine, an oil or gas well, a quarry or any other place of
extraction of natural resources
If Lifestyle Limited sets up a branch in the Mainland selling its products, this
likely constitutes a permanent establishment and the profits attributable to the
branch will be subject to corporate income tax in the Mainland
To eliminate any double taxation, tax paid in the Mainland by a Hong Kong
resident shall be allowed as a credit against Hong Kong profits tax under
Article 21 if the profit is subject to Hong Kong profits tax.
However, the amount of the tax credit shall not exceed the amount of Hong
Kong tax on such profits computed in accordance with the tax laws and
regulations in Hong Kong
8
SECTION B
2.
Henry Bao is the Vice-president - Engineering of Sapphire Limited (Sapphire), a company
carrying on business in Hong Kong. He provides you with the following information relating
to the year ended 31 March 2012:
1. He received a monthly salary of $50,000 for the year, and a discretionary bonus of
$85,000.
2. He was provided with company quarters at a nominal rent of $3,000 per month. He
also paid the management fee of $13,200 for the year.
3. He received a holiday package for his home trip to Taiwan, which was purchased by
Sapphire from Wing On Travel Agency for $10,000. The package can be redeemed for
cash after deducting a handling charge of $2,000.
4. He engaged a domestic helper at a monthly salary of $5,000 which was paid by
Sapphire on his behalf.
5. He was enrolled in Sapphire’s MPF-exempt retirement scheme. During the year, he
has made contribution at 5% of his monthly salary to the retirement scheme.
6. He was also enrolled in Sapphire’s group medical insurance scheme. During the
year, he obtained a medical refund of $8,000 from the insurance company, and
another $3,000 which was not covered by the insurance from Sapphire pursuant to the
terms of his employment.
7. On 1 April 2011, he was awarded 50,000 shares in Sapphire. The shares were vested
on him immediately with a sales restriction period of one year from the date of the
award. On 10 December 2011, he received dividend income of $5,000 from these
shares. He sold all these shares in the market on 15 May 2012.
8. On 2 February 2012, he was granted an option to subscribe for 100,000 shares in
Sapphire at a $3 per share. This share option was granted without condition. He sold
one half of the option on 9 March 2012 and received $180,000.
9. During the year, Henry paid a membership subscription of $1,900 to the Hong Kong
Institution of Engineers. He also paid $3,000 to attend continuing professional
development seminars organised by the Institution.
10. Henry is married and his wife, Annie, is a housewife. They have a son, aged 20,
attending university in the US. Annie’s parents, aged 57 and 63, reside in Hong Kong.
Annie paid them $6,000 per month in support of their living.
In September 2012, Henry was approached by a head-hunter and was offered a three-year
contract to work in a company based in Singapore. Henry resigned from Sapphire effective
from 1 December 2012 and will permanently leave Hong Kong by early January 2013. He
has not yet exercised the remaining share option mentioned in note 8 above.
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Sapphire’s shares were quoted on the stock exchange at the following prices on the
following dates:
1 April 2011 $6.00
2 February 2012 $8.00
9 March 2012 $7.00
1 April 2012 $7.50
15 May 2012 $7.20
30 November 2012 $6.50
REQUIRED:
2. (a) Prepare the Hong Kong salaries tax computation for Henry Bao for the
year of assessment 2011/12. Ignore provisional tax.
Ans (a) Henry Bao
Salaries tax computation
Year of assessment 2011/12 $ $
Salary ($50,000 x 12) 600,000
Bonus 85,000
Holiday journey 10,000
Salary of domestic helper ($5,000 x 12) 60,000
Medical refund 3,000
Share award (50,000 x $6 x 0.95) 285,000
1,043,000
Rental value [($1,043,000 - $1,900) x 0.1] 104,110
Less: Rent suffered ($3,000 x 12 + $13,200) (49,200) 54,910